Financial Markets Book Financial Markets For The Rest Of Us
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
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by Robert Hashemian

Page 316

you have profited from the price swings. Now you may wish that there were a mechanism whereby you could buy the FAJ and FMJ contracts in one shot, saving yourself the time and commission of entering two separate orders. Enter combinations, or as they are sometimes referred to, combos.

Combinations allow you to take different positions in different options in one trade. The above example is a type of combo known as a straddle. There is yet another side to the above example that is more practical. The investor may expect a big move for Ford but be unsure of its direction. In that case the straddle position would also come in handy with each contract acting as protection against the other. Suppose you have 1 FAJ and 1 FMJ contract and Ford just shoots up to $60. In that case your FAJ contract will be sufficiently profitable that it would cover your loss on FMJ and still leave you with a profit. On the other hand if Ford dives to $40 you would still realize a net profit with your FMJ contract, even though your FAJ contract would be a loss. The downside? If Ford doesn't exhibit enough volatility, you would lose money on both contracts or your profits on one contract may not be enough to cover your loss from the other. As you might have guessed, a straddle position is bought by an investor (long straddle) who is speculating that a stock will be volatile but is unsure of its direction. The same straddle position is sold (written) by an investor (short straddle) who is speculating that the underlying stock will be stable through expiration. A straddle position in which both options are out of the money (same expiration and same underlying stock) is sometimes referred to as a strangle, an example of which would be buying an FAK (January 55 call) contract and writing an FMI (January 45 put) contract at the same time when Ford is trading at $50. Both options are $5 out of the money in this case and thus a strangle position is established.


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